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Friday, 24 August 2012

Euro crisis: Fix it or Fixit

I liked the feature in today's The Economist which explains why Finland might start finding the cost of staying in the Euro as unbearable and will be constrained to choose between a Fix it ( Fix the Euro system) or Fixit (Finland Exit from the Euro).

The infinite billion Euro question is: how do you fix it?

It is now fairly obvious to anyone with eyes to see and brains to think that Greece can never restructure within the Euro. Without an external devaluation that is impossible within a monetary union, Greece's adjustment will spread continuous pain over too a long a period for any democracy to tolerate. Too many resources are being wasted as they are poured into a Hellenic black hole and it is time to accept that no matter how painful, Grexit is inevitable. Resources should be saved to build a firewall around the other countries that are successfully restructuring within the Euro ( Spain, Italy, Portugal and Ireland) as a Grexit without such a firewall will cause very damaging contagion.

If it comes to choosing between Grexit and Fixit, then surely we should go for Grexit and then set out to 'fix it' rather than choose Fixit.

I sense a new realism among EU political leaders. The summer lull seems to have sharpened their thinking. They know that the Euro can never be stable with Greece trapped in a harrowing deflation and they are preparing for the inevitable consequences of Grexit. Only this explains Merkel warming up to the initiative of monetary easing being orchestrated by ECB President Draghi in spite of the fundamentalist objections of the German Central Bank. Merkel has decided to overrule her own Central Bank and back Draghi. And this with good reason.

No other institution but the ECB can save the Euro. No other institution has the autonomy to move with speed and resources that can shock and awe the market and bring back stability in the borrowing costs of the countries successfully restructuring their economies, especially Spain and Italy whose economy is simply too big to save through bailouts.

We should soon see the ECB applying unlimited resources to achieve three things:

Provide limitless liquidity to build a firewall against contagion from Grexit

Monetise whatever is necessary to capitalise back to health Euro area banks that have to write off the bad assets on their books, being irrecoverable property loans or doubtful loans to sovereigns.

Intervene directly in the secondary market to put a cap on the maximum spread tolerance Euro sovereigns have to pay to borrow on the markets. Otherwise the sacrifices Italy and Spain are doing to achieve restructuring will be wasted in higher funding costs.

A monetary solution from the ECB would avoid the messy approval by 17 parliaments for funding which would put their own budgets, already under recession stress, further under pressure. It would avoid issues regarding the consistency of such funding in terms of the German Constitution. And importantly it would break the depressive spiral between the fragility of the banks' balance sheet and the worrying deficits of their sovereigns. If as a result we see a devaluation in the exchange value of the Euro than that would be part of the restructuring cure as a lower Euro will lead to increased competitiveness.

EU leaders must use the time which the ECB will offer through its extraordinary monetary initiatives to restructure the Euro system to health by underpinning it with a banking union, a Euro-wide banking regulatory system, and plans for a fiscal union leading to common Eurobond funding under strict conditionality.